Funds bitten by Apple will be twice shy
With its mighty tumble, big holders won't be quick to buy again.
A 37% plunge in just 18 weeks. It's tough to imagine such a dramatic pullback from any well-entrenched stock, but it's nearly impossible to digest when it's Apple (AAPL) -- the undisputed king of cool technology.
Had it just been the slide lower during the last quarter of 2012, it might not even be a point worth discussing. But in the shadow of its latest earnings report and outlook (coupled with the stock's tumble to new multi-month lows), is Apple now causing a major ripple effect for the mutual fund and exchange-traded fund industries?
The answer: Yes -- and no.
Too much of anything is still too much
Some of the statistics surrounding Apple are nothing less than amazing. The fact that it's the most widely owned stock shouldn't be one of them. After all, it's also one of the world's largest companies, and was the largest for a big chunk of 2012.
Yet, some numbers are still amazing, even if Apple is a monster. AAPL shares are owned by 17% of individual investors. That's huge. More than 5,000 mutual funds also own at least a small stake in Apple. And these retail investors and institutions own more than a mere token amount of the company.
One out of every five hedge funds reports that Apple alone is one of its top 10 positions (by size), while at least 800 mutual funds acknowledge that AAPL is a top 10 holding as well. Institutional ownership of the stock still tops out at 68%, which isn't all that abnormal, but given the clamoring retail investors have been making for the stock, it's a bit surprising that institutions were able to compete with unusually strong retail demand.
There's an inherent problem when Apple is so prolifically owned, not just by institutions, but also by active fund managers and rabid retail buyers -- once an exodus begins, it quickly becomes an avalanche.
With AAPL falling under that key psychological price level of $500 after a 28% pullback, that exodus is more than underway.
Who's most affected?
If you're an owner of the PowerShares QQQ Trust (QQQ) -- aka the Q's or the "cubes" -- or the Technology Select Sector SPDR (XLK), the last four months haven't been fun. Both ETFs are cap-weighted, meaning the bigger the company, the bigger the fund's exposure to it. Before the most recent dip, Apple made up 16% the Q's underlying portfolio, and 17% of the tech SPDR's portfolio, dragging both funds down during Apple's implosion.
It's not just tech funds that are suffering. Even broad-based indices like the S&P 500 or related funds like the SPDR S&P 500 ETF Trust (SPY) currently rely on Apple for 3.7% of their performance. That's down from just a tad under 5% in September.
One thing to bear in mind, however: Just because Apple shares lost a significant chunk of their value doesn't mean these exchange-traded funds (ETFs) and index funds are putting more selling pressure on Apple. These funds and trusts are established to hold a basket of select securities, and hold them indefinitely, for better or worse. The selling pressure we're seeing now is solely coming from individual investors and institutional portfolios.
And make no mistake -- active fund managers (especially growth-oriented fund managers) are selling. They said so. In a recent Bernstein Research poll of 800 mutual fund managers, stakes of Apple in growth funds had been reduced, and not just because the stock's price had contracted. Ironically, value funds have upped their exposure to AAPL, now that it's looking and acting like a value stock.
Don't count on those growth fund gurus or individual investors to plow back into Apple anytime soon either, or as firmly as they did last year. Once burned, professional and amateur investors alike have a hard time going back to the same well.
Who's least affected?
For the same reason that cap-weighted funds and ETFs like the PowerShares QQQ Trust saw exaggerated losses, equal-weighted funds and ETFs didn't get hit as hard. Some of these include the First Trust NASDAQ-100 Equal Weighted ETF (QQEW) or the Guggenheim S&P 500 Equal Weight Technology ETF (RYT). Unfortunately, neither of these funds is as closely watched or owned as their more common cap-weighted counterparts.
The last word
Though any Apple-rooted ripple effect is purely academic at this point, there's still a lot to be learned from AAPL's implosion about herd mentality.
To give credit where it's due, it was Jeremy Grantham who poetically penned what Apple's been through over the last year or so, by saying:
"The central truth of the investment business is that investment behavior is driven by career risk. In the professional investment business we are all agents, managing other peoples' money. The prime directive, as Keynes knew so well, is first and last to keep your job. To do this, he explained that you must never, ever be wrong on your own. To prevent this calamity, professional investors pay ruthless attention to what other investors in general are doing. The great majority 'go with the flow,' either completely or partially…. Missing a big move, however unjustified it may be by fundamentals, is to take a very high risk of being fired."
Said another way, Apple's stock saw a great deal of success in 2012 because the proverbial planets lined up, and the market -- institutions and individuals alike -- largely created their own self-fulfilling prophecy. Yet, that's a zero-sum game. The bulk of those outsized gains from 2012 have been wiped away, as the pullback simply encouraged more and more selling on the way down.
The irony? Apple isn't a bad company. It's an undervalued stock now, thanks to the pullback. Its trailing price-to-earnings ratio of 10.1 and forward-looking one of 8.7 are actually quite attractive to value seekers, institutional or otherwise, which is why value-oriented mutual fund managers admit to ramping up their exposure. Value funds' demand isn't ready to outpace the growth funds' supply, though.
Some have opined that Apple will also start showing up in some income-oriented portfolios as well, but that's not a highly plausible outcome here. The dividend yield of 2.1% is still pretty minimal (even with the sharp pullback), and if Apple follows through on its plans to unveil a lower-price iPhone this year, margins will deteriorate. Though Apple could still afford to pay the dividend, it's not a company that’s ever come across as making a dividend a priority.
Apple fans and optimists expecting a sharp rebound because of revived buying by growth funds are likely to be disappointed. This is one of those scenarios where it would be socially and professionally difficult to show AAPL as a portfolio position now that it's demonstrated it can dole out huge losses in short order. Grantham was right in that respect: Now that Apple has burned so many professional stock-pickers, it's not going to gain favor again anytime soon, especially with that tumble under the key $500 mark.
Bottom line? Apple's stock isn't going to be returning to its institutionally driven glory days anytime soon.
As of this writing, James Brumley didn't own any securities mentioned here.
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